Banks, Bitcoin & the Blockchain

The Bitcoin Blockchain could offer benefits to banks that are willing to experiment with it.

The modern financial system has a fundamental problem: It’s not designed for the Internet. Even though money and transactions are becoming increasingly digitized, we keep using payments rails that were originally designed for paper checks. And, in some ways, the financial system is less than compatible with the online world people are shopping and transacting in.

A good example of this conundrum is how the Internet has affected payments security. JPMorgan Chase, which suffered a data breach this past summer, will likely double its $250 million annual cyber security budget in the next five years. Our payments rails just weren’t built with advanced persistent threat attacks and malware in mind.

“All of the work that people are doing in cyber security, it’s really people are trying to patch for that problem… that our financial system wasn’t built for the Internet,” Will O’Brien, CEO of BitGo, said yesterday at a Money2020 panel on how traditional payments players can dabble in Bitcoin.

Bitcoin was built for the Internet. Strip away the currency aspect and look at the technology behind Bitcoin, and you have the first Internet protocol for storing and exchanging value. And that protocol leverages the Blockchain, the first open-source financial database that records everything that happens on the Bitcoin network and verifies all of that activity with a third party. The implications of the Blockchain technology could go well beyond payments. So there are opportunities for companies beyond Bitcoin startups to leverage it.

“Bitcoin is potentially the most important technology innovation of our lifetime. It has such far-reaching potential,” Cedric Dahl, CEO of Buttercoin, remarked. “The Blockchain has enabled something that has never been possible before: Two people who don’t know or trust each other can agree that they trust each other with something.”

The Bitcoin Blockchain could be used to verify more than just possession of funds for Bitcoin transactions. It could be leveraged to verify all sorts of records like legal documents. Or it could be used to verify the credit-worthiness of unbanked or underbanked individuals, Adam Ludwin, CEO of Chain.com, commented.

“The real value of the anonymity of Bitcoin is that you don’t need to know your customer. The Blockchain can substitute for the credit-worthiness of an individual. It can enfranchise people and bring them on to the financial grid,” Ludwin said.

It might not look as if these things are possible yet, as Bitcoin is still in its early days. And Bitcoin companies acknowledge that more innovation is necessary for the Blockchain technology to reach its full potential.

“People need to build and develop on top of the Blockchain for this foundational technology to reach consumers,” Halsey Minor, CEO of Bitreserve, observed.

Given the far-reaching potential that Bitcoin advocates predict this technology will have, there’s no reason banks couldn’t participate in the development and innovation around the Blockchain. While some banks are experimenting with Bitcoin in different ways in their innovation labs, the Blockchain will be the starting point for any traditional financial services provider to have an impact with Bitcoin’s technology, Chain.com’s Ludwin suggested.

For companies looking to dabble in Bitcoin’s technology, “they need to connect to the Blockchain,” he advised. “If you think about what previous Internet protocols have done, they bring down costs and open up new markets. Think about the impact that email and voice-over-IP have had. You need to think in terms of what the Blockchain combined with your brand can do.”

Bitcoin and its technology aren’t perfect; their flaws have been well covered in the media. But those problems are also opportunities for new innovation, Ludwin pointed out. “Those problems are an opportunity for someone… to leverage the power of the Blockchain.”

Banks might be able to take advantage of those opportunities if they’re willing to experiment and take some risks.

Jonathan Camhi has been an associate editor with Bank Systems & Technology since 2012. He previously worked as a freelance journalist in New York City covering politics, health and immigration, and has a master's degree from the City University of New York's Graduate School ... View Full Bio

It's definitely way too early to start rolling out some kind of product with Bitcoins or that leverages the cryptographic technology behind Bitcoin. But this is the time to be exploring those kinds of things. Even most people within the Bitcoin community say it will be several years before there is mainstream acceptance of the currency ro the technology behind it. Read the quote from Halsey Minor in the piece, there is a lot of development still to be done. But banks should be exploring ways to leverage this technology. The blockchain and cryptography are going to be influential technologies going forward, even if the best use cases for them aren't as a currency (see the link provided for some examples of other possible use cases).

Also, regulators are working on trying to understand Bitocin and the technology behind it. Check out what Ben Lawsky and New York State Department of Financial Services have been doing. And the Bitcoin community is actively trying to reach out to regulators and build that understanding. Regulators are definitely wary about Bitcoin being introduced into the traditional financial system here right now, but that is going to change over time. It's best to be in a position to take advantage of that as it changes. So it's a good move to be experimenting with this technology in the innovation lab, and having conversations around how it could help.

And I think there is a middle ground between paying fines or trying to win the fight against the government. It's called having controls and safeguards in place to make sure you're operating by the laws and regulations. Banks have invested a lot in those. And we see in surveys that bankers are much more confident right now about their compliance with regulations then they were just a few years ago. I don't think they would be more confident if the regulators were telling them that those investments were complete failures. And they definitely wouldn't be feeling that confident if they thought regulators were going to come in and fine them for no reason at all.

Clearly any experimenting with the blockchain or cryptogrphic transactions would have to clear those risk and compliance controls. But we already know that banks are playing around with this technology in their innovation labs. Again, it's too early to roll out products and services. But that kind of experimentation is a good idea at this point.

"there's no reason banks couldn't participate in the development and innovation around the Blockchain."

Ummmm...

How can it be that the author references JP Morgan Chase and does not know that every bank lives in constant fear of the government coming in and picking all the meat off the bones with fines. There's no reason? Really? Try talking to a lawyer who works for a bank. It turns out there doesn't have to be a reason for regulators to fine a bank if that is what they intend to do. And bitcoin would be openly daring the government to fine the bank. The bank can fight the government and possibly even win, but everybody know there will be no bank left over after the fight is done. That is how it works. You pay the fines or you die trying to win the fight against the government.

In the first place, people notice right off the bat that vending machines are not ATMs. So, I would ask a bank who would be the cash in transit service that buys the bitcoins from the ATM owner? And would you deploy one of these phony cheap junk vending machines instead of using your own ATM group to simply add the additional functionality of bitcoin to your already existing hardware? And what would you do about the ATMs that are placed in public access or drive up ATMs? How would you stop people from loitering so they can cut to the front of the line and sell bitcoins at a slightly less markup? Usually, people do not like to be approached when using an ATM. I think your customers would intentionally avoid your ATM becausee they would learn after the very first time that people selling bitcoins would be trying to be intercept your transactions.

Also, bitcoin is infinitely divisible. This means that there never was any HONEST reason for the creation of more than one bitcoin. 21,000,000 bitcoins will not make bitcoin any more rare than it ever was in the first place when the very first one was made. It is going to get very ugly. you watch.